Private Mortgage Insurance (PMI) protects the lender from financial losses if you default on your mortgage payments. The mortgage insurance will pay off the balance of your home loan (or a portion of the loan) if you stop making your payments.
PMI is required when you don’t make a 20 percent down payment since lenders may view you as more likely to default on your mortgage payments. Mortgage insurance works differently depending on the type and size of the home loan, the credit score among other factors. The costs can range between 0.3 percent and 1.15 percent of your loan annually.
Does mortgage insurance make sense? Yes. And in these 3 situations, it could be worth it.
1. Home Prices Are Rising Too Fast
When home prices are rising fast and you don’t have the 20 percent down payment, it is worth paying PMI. Mortgage insurance makes buying a house in an area that is heating up possible.
Assuming a home costs $280,000. You’ll need to save $56,000 to put down 20 percent on the house. You already have $20,000. You can buy now before house prices go up or wait to save the full $56,000 and avoid private mortgage insurance costs.
After two years, that home is worth $305,000. You’ll need $61,000 for the 20 percent down payment. It’s an extra $5,000 which you might not have. And, even if you did have it, you’ll have missed out on the appreciation of the housing market by opting to save for down payment.
You might not catch up with the rising home prices in a hot housing market. Plus, all that time you were saving to meet the 20 percent threshold; you could be paying down your mortgage instead of spending money on rent.
2. Increasing Mortgage Interest Rates
Waiting may cost you -the value of a home might go up along with mortgage interest rates. Even when you pay for private mortgage insurance, your monthly mortgage payments will be less than what your mortgage payments will be if you wait.
Buying a house now with a $20,000 down payment would save you money than waiting 2 years to put $61,000 down on a $305,000 home.
3. You Need Cash for Other Financial Goals
Though you might have the 20 percent down payment right now, you might not want to tie up every cent you have in your home (just to save on mortgage insurance).
Private mortgage insurance allows you to put less than 20 percent down payment and still get a conventional loan. That way, you’ll have some cash available for other financial goals. You could pay down credit card debt, build your emergency fund or invest the money and earn higher returns. Remember, once the down payment is home equity, you can only access your money through a home equity loan, making it less liquid.
Is Mortgage Insurance Really Worth It?
From the scenarios above, private mortgage insurance makes sense. However, you should know there are risks involved when you decide to commit to mortgage insurance now with expectations of future benefits.
Some of the risks include, mortgage rates might not rise as much as expected. A crash in the housing market means you might have to wait longer to realize appreciation in home equity. It could take years before you get rid of the PMI. In the event of these circumstances, mortgage insurance could end up being an extra cost.
Still, while mortgage insurance can be ideal in the 3 cases, saving up a 20 percent down payment has its advantages. Putting down 20 percent has a greater chance that you’ll have the capital to ‘cash out’ when you sell your house. You could use the capital to help you relocate or make a down payment on a different home.
You will need to understand your situation and weigh the risks involved before choosing the best option. All this is to say, you alone can answer the question “Is mortgage insurance really worth it?”